Financing Home Repairs (2006)

This publication outlines some ways to finance repairs and improvements to your home and how to protect yourself from home improvement problems that might cost you money. It covers personal loans, Federal Housing Authority (FHA) loans, home equity loans, and for veterans who live in California, CalVet loans.

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Financing Home Repairs

Keeping your home in good repair can make it livable, protect its value, improve energy efficiency and prevent expensive major systems from needing to be replaced. But every home needs repairs sooner or later and home repairs can be expensive so most homeowners take out a loan to pay for the work.

Many home improvement loans require that you allow the value of your home to be used to guarantee the loan, although in some cases you can guarantee the funds using another source, such as your savings. If your home or property will guarantee the loan, you will be asked to sign a “deed of trust” that allows the lender to recover its funds if you don’t pay the loan back. This is sometimes called a “lien” on your property. Contractors can also place liens on your property if you do not pay for work they have done for you.

Here are some ways to finance repairs and improvements to your home. To be approved for most loans, you must have a satisfactory credit history.

Personal Loans

Personal loans, usually for a relatively small amount (from a few hundred to a few thousand dollars), are obtained from a bank, finance company or credit union and do not involve a lien on your home or property. Some form of collateral may be required, such as a savings account. If you default on the loan, the lender will place a hold on the funds in the savings account. Personal loans are “unsecured” loans, meaning that they are not guaranteed by property you own. Interest rates on unsecured loans are generally higher and the time for repayment is usually shorter than with secured loans, but no lien is placed on your property.

Some life insurance policies, annuities and retirement plans allow you to obtain a loan of a portion of your equity at a very low interest rate. The face value is then reduced by the amount of the loan until you repay. (Equity is any portion of an asset that you own outright, without mortgages, liens or other claims by companies or individuals.)

Many credit cards allow you to obtain a cash advance. This will not result in a lien against your property, but you’ll probably pay very high interest rates and your interest rate can skyrocket to 20%-30% or sometimes even higher if you are late with payment on your credit card.

FHA Title 1 Loans

The Federal Housing Administration (FHA) of the U.S. Department of Housing and Urban Development insures Title 1 home improvement loans. FHA loans are the easiest type of real estate mortgage loan to qualify for. The loan is obtained from a private lender, but FHA insures repayment of the loan. These are fixed-rate loans and certain small loan amounts do not require a lien against your property. FHA loans do not have a prepayment penalty.

The FHA will insure loans for remodeling, room additions and plumbing, electrical or heating repairs. Title I loans may be used to finance permanent property improvements that protect or improve the basic livability or utility of the property—including manufactured homes, single-family and multifamily homes, nonresidential structures, and the preservation of historic homes. The loans can also be used for fire safety equipment.

The maximum loan amount is $25,000 for improving a single-family home or for improving or building a nonresidential structure. For improving a multifamily structure, the maximum loan amount is $12,000 per family unit, not to exceed a total of $60,000 for the structure. You can get a loan of up to $25,000 even if you don’t have any equity built up in your house. The program can insure loans for up to 20 years on single or multifamily properties.

Eligible borrowers include the owner of the property to be improved, the person leasing the property (provided that the lease will extend at least six months beyond the date when the loan must be repaid), or someone purchasing the property under a land installment contract. Basic FHA loan qualification guidelines are:

You’ve had two years of steady employment, preferably with same employer.

Your income for the past two years income is steady or has increased.

Your credit report should show no more than two 30-day late payments in the last two years.

Bankruptcies must be at least two years old, with good credit performance since the bankruptcy.

Foreclosures must be at least three years old, with good credit performance since the foreclosure.

Your new mortgage payment (including the payment for the new, FHA loan) should be about 30% of your gross income.

Cal-Vet Loans

The California Department of Veterans Affairs makes loans directly to qualified veterans (Cal-Vet Loans). These loans are offered at competitive interest rates, in both fixed rate and adjustable rate mortgages. The terms compare favorably with traditional loans. Holders of CalVet loans are eligible for additional home improvement loans at lower-than-average interest rates.

You are eligible for a CalVet Home Loan if you received a discharge classified as Honorable or Under Honorable Conditions, and you served a minimum of 90 days active duty, not including active duty for training purposes only. Most veterans are eligible, including service men and women whose entire active service was during peacetime.

Exceptions to the 90 days service requirement:

Veterans who were discharged sooner due to a service-connected disability, or

Veterans eligible to receive a U.S. campaign or expeditionary medal, or

Veterans who were called to active duty from the Reserves or National Guard by Presidential Executive Order.

Current members of the California National Guard or the US Military Reserves who have served a minimum of one year of a six year obligation are also eligible provided they qualify as first time home buyers or purchase properties located in certain areas.

Current CalVet Loan Holders qualify for CalVet Home Improvement Loans at competitive interest rates. If you do not currently have a CalVet mortgage loan, you may have to pay title and escrow fees on the home improvement loan. These improvement loans may be used on houses, condominiums, farms (for improvements to the main dwelling only), and mobile or manufactured homes located on land owned by the loan holder. Improvement loans may be used to:

Improve the livability of your home or property

Increase energy efficiency

Perform general maintenance, like painting, re-roofing, and general repairs

Contractor-Originated Loans

Some contractors have arrangements with lending institutions that allow the contractor to offer home improvement—these are called “lien contracts.” However, contractor-originated loans have been associated with scams so always ask a lawyer or non-profit housing counselor to review the loan terms before you sign any loan application referred by a home improvement contractor. Check on contractors with your local Better Business Bureau.

Lien contracts involve the placing of a lien or deed of trust against your home or property so that if you don’t make your payments, the lender can foreclose on your property and sell it at a public auction to collect what is owed. If this happens, the home or property owner rarely receives anything from the sale no matter how small the debt and all equity in the home or property will be lost.

Do not sign a contract or any other document unless you completely understand all its terms. Look especially for a bad contract terms called a balloon payments, which entails low interest-only monthly payments for several months or years and then a large in-full payment of the entire loan balance. All lien contracts must contain disclosures of the full cash price, down payment, amount financed, interest rate and finance charge, amount and dates of periodic payments, total payments and total deferred payment price. They must also contain a written notice of your right to cancel the contract within three days. Additional consumer protection requirements are triggered for primary home loans with interest rates that are eight percentage points above Treasury bills of equivalent terms and secondary home loans that are 10 points above, and on loans in which the total points and fees exceed federal guidelines.

Home Equity Loans

These loans are secured by a deed of trust against your home or property. Even if you have poor credit, you may be able to get a home equity loan if you have substantial ownership in your home. When shopping for a home equity loan, be very careful because you might agree to terms you cannot afford, such as monthly payments that are higher than your monthly income and high loan fees or "points" (one "point" is 1% of the total loan amount). By paying points, you should receive a substantial reduction in the interest rate on the loan. Banks usually charge from zero-4 points—any higher amount should be a red flag that you may be dealing with a disreputable lender.

Generally, you can borrow against the equity in your home in two ways—by taking a lump sum “home equity loan” or by taking a HELOC (home equity line of credit) that allows you to withdraw the money as you need it.

A home equity loan may be the best option if you plan to use the money in a lump sum because you may qualify for a fixed interest rate and your monthly payments will be predictable.

But a HELOC may give you more flexibility if you don’t need the money all at once. HELOCs usually have variable interest rates, which mean they rise and fall in each month that current interest rates move. For example, during a major home remodeling project, you usually pay the contractor in installments when major milestones in the project are completed. With a HELOC you will pay interest only on the money you access. (Many HELOCs have annual fees and requirements that you keep them open for a minimum number of years. You can pay the HELOC down to zero, but you still may be responsible for a minimum number of annual fees.)

The Community Reinvestment Act (CRA)

The Community Reinvestment Act requires financial and lending institutions to meet the credit and banking needs of all the communities in their service area, including low income and minority communities. There may be special funds or loan programs available to low- and moderate-income individuals through banks that are members of the Federal Home Loan Bank (FHL Bank) system. The FHL Bank represents banks and credit unions in the 50 states, Guam, American Samoa and Puerto Rico.

Protect Yourself

In California, the Contractors State License Board (CSLB) licenses and regulates contractors in more than 40 license classifications that constitute the construction industry. The CSLB also registers home improvement salespersons, and offers arbitration for resolution of disputes that meet certain criteria. The agency provides consumer information and allows consumers to verify the license status of a contractor. Contact the 24-Hour Licensing and Consumer Information at 800-321-2752.

If your lender is making direct payments to the contractor, check with your lender to make sure that money is paid to the contractor only when work is fully completed and has passed necessary building and zoning inspections. Lenders usually require a signed completion certificate before they will release the last payment.

Never sign a completion certificate until all the work called for in the contract has been properly completed. When a project is complete, the building department will make a final inspection, so don't make the final payment to the contractor until the building department inspector has signed off on the job.

Require that contractors provide you with proof of a performance bond.

Call your tax assessor’s office to ask whether taking out a loan and making improvements to your home will cause your property taxes to be raised.

Play it safe and ask legal aid, a private attorney or a fair housing organization review and explain all papers to you before you sign. To find legal aid services near you, visit the Legal Services Corporation web site and use the “Find Legal Services” state-by-state directory.